Top 3 Federal Tax Updates Employers Need to Know for 2026

The start of a new year brings heightened attention to compliance. And no wonder—mistakes like failing to comply with I-9 requirements, misclassifying employees, and making payroll errors all add up to hefty costs and major HR headaches.

In 2026, several federal updates will introduce meaningful changes to how organizations handle payroll, retirement plans, and tax reporting. From new requirements around Roth catch-up contributions to expanded tax deductions for tips and overtime, and long-awaited guidance on state paid family and medical leave taxation, these developments will require thoughtful coordination across HR, payroll, and benefits teams.

Below, we break down the three most impactful federal changes every employer should understand to remain compliant and continue supporting your people in 2026.

Roth catch-up contributions now mandatory for certain employees

According to updates to the Secure Act 2.0, employees who are 50 years old or olderwith more than $150,000 in wages for 2025 must direct all of their 2026 catchup contributions to their Roth (after-tax) retirement accounts. This provision, originally delayed from 2024, applies to 401(k), 403(b), and some governmental plans. The $150,000 threshold for 2026 is subject to change on an annual basis.

Your HR, payroll, and benefits administrators should collaborate to do the following:

• Accurately track which employees fall under this provision
• Include a Roth option in your retirement plans
• Communicate to your eligible employees that their catchup contributions will need to be Roth contributions

If your plan includes the option to allow employees who are 60–63 years of age to contribute the super catch-up contribution, then those employees who earn above the $150,000 threshold will also need to make the super catch-up contributions as Roth contributions.

New federal income tax deductions for tips and overtime

The One Big Beautiful Bill (OB3), signed into law on July 4, 2025, allows individuals to deduct qualified tips and qualified overtime compensation on their personal federal tax returns. This provision—which has a retroactive effective date of January 1, 2025—does not modify federal withholding, but still requires actions by your HR and payroll departments.

The qualified tip deduction allows employees in occupations that “customarily and regularly” receive tips to deduct up to $25,000 of their qualified tips from federal taxable income. The IRS has released a draft list of occupations that will qualify for this deduction. The tips must also be voluntarily paid by the customer and have the customer determine the amount for the tips to qualify as a qualified tip. Therefore, mandatory service charges are not considered qualified tips.

Individuals can also deduct up to $12,500 for qualified overtime compensation, subject to income thresholds. For this provision, only the overtime premium under FLSA requirements may be deducted.

Overtime compensation deduction example

If an employee worked 10 hours of overtime in one week while earning $20 an hour of regular time and $30 an hour as the overtime rate, the employee will be able to deduct $10 an hour (the premium rate) multiplied by the 10 hours of overtime worked in the week—a total of $100.

While some states allow for overtime to be calculated on a daily basis and some collective bargaining agreements allow for overtime to be earned in situations outside of the FLSA, only overtime as defined by the federal FLSA is allowed to be deducted. This may require some employers to simultaneously track overtime earned at the state level and at the federal level to accurately pay state overtime wages and accurately report the qualified overtime compensation that can be deducted for the 2026 tax year.

Federal taxation of state Paid Family Medical Leave (PFML) premiums and benefit payments

In Revenue Ruling 2025-4, the IRS provided long-awaited guidance on how contributions to and benefits paid from state PFML programs are treated for federal income and employment tax purposes.

The IRS clarified the following for the PFML premium payments:

• Employee contributions are included in the employee’s federal gross wages on the Form W-2.
• Required employer contributions are not included in the employee’s gross income.
• If an employer pays part or all of the employee’s required contribution, the portion that the employer paid (the “employer pickup”) is considered taxable wages and included in the employee’s gross income on the Form W-2.

The taxation and reporting of the state PFML benefit payments depends on whether the payment is for family leave or medical leave.

Family leave benefit payments are included as gross income but not considered wages and are not subject to FICA or FUTA. These payments will be reported by the state that issued the payment on a Form 1099 and sent by the state to the employee.

The taxability of medical leave benefit payments depends on the source of funding:

• The employer-funded portion is taxable and subject to FICA/FUTA.
• The employee-funded (after-tax) portion is excluded from gross income.
• If there is an employer pickup portion, that is also excluded from gross income.

The medical leave benefit payments will be reported in a similar fashion as third-party sick pay.

With these new requirements for the new year, we encourage you to be proactive in coordinating with plan administrators, educating employees on the changes, and making any necessary adjustments in your BambooHR^® profiles to have a strong and compliant start to 2026.